Predatory Pricing Meaning Examples Effects Vs Limit Pricing

Predatory Pricing Meaning

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Predatory pricing in economics represents an approach towards establishing a monopoly of a brand, driving off competition. US antitrust laws consider such pricing strategy illegal as it leads to unhealthy market competition with only one business dominating the entire market, making it tough for the competing brands to grow and survive.

Predatory Pricing Explained

A predatory pricing strategy attempts to sell products and services at such a low price that consumers do not even look at the competing brands. The main motive of consumers is to buy an item for the lowest price possible. And this pricing approach targets that particular mentality of the buyers. As a result, the competitors find it hard to survive in such an environment and leave the competition. Driving off competitors is the ultimate aim of this pricing trick, which thereby gradually establishes a monopoly in the market.

Key Takeaways

Predatory pricing refers to a pricing strategy where a brand offers products and services at significantly lower costs, thereby eliminating competition.In this case, competitors prefer quitting rather than competing as they cannot bear such huge losses and survive.This pricing strategy establishes a monopoly in the market.While consumers get a chance to buy products at lower costs due to this strategy, they are equally affected when there is no further scope to decrease prices, and the product costs increase suddenly.

The predatory pricing diagram below specifies the characteristics of the strategy:

In addition to removing the market competition, the pricing also creates barrier to entryBarrier to EntryBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant.read more. As the new entrants notice the lowering prices of the products, they understand it would be difficult for them to survive. When the prices are too low, the manufacturers and brands suffer huge losses as their production cost is higher and the price at which they have to sell those items is too low. In such a scenario, the scope for both growth and survival becomes doubtful.

When no customer is ready to spend on a brand, it loses recognition and gradually disappears from the market without its own fault. Thus, the strategy is considered illegal per the antitrust laws, given the price disparity it causes in the market while leaving no other option for competing brands but to quit.

Market Effects

This pricing strategy benefits customers in the short and long term as they get a chance to buy goods or services at a very low price which they might not be able to get in normal situations.

From the perspective of the companies in the industry, this is harmful as they have to reduce the product prices to compete, which creates a situation where they find it difficult to survive.

However, there comes a time when the limit to lower prices is reached, and the product prices start rising. This is when customers find it difficult to cope with the continuous price hike after enjoying the same products/services at significantly lower costs. The high prices severely affect their budgetary constraints.

Examples

Let us consider the following predatory pricing examples to understand the concept better:

Example 1

Several retail stores in the town sell various products to the people living in the local community. Suddenly, the renowned ABC departmental chain opens one departmental store and set the price of all the products at a level lower than that of the retail stores.

Customers start going to the ABC department store as they get a chance to buy the same products at a lower price; thus, the entire retail setup gets affected and starts losing customers. Initially, retail stores lower their prices due to significant price pressure or to match the competitor’s price to regain customers. Eventually, they all closed their stores as they could not survive in the current situation.

With the closure of the retail stores, a monopoly is created in the market, taking advantage of which ABC increases the product prices, leaving no option for customers to switch to.

Example 2

In 2016, Flywheel Taxi claimed that Uber opted for predatory pricing to reduce the ride costs and reap huge profits in the future. It alleged the brand of using billions of dollars to achieve the same. In the process, it lost money on every UberX and UberXL ride in San Francisco. The former sued the latter in US District Court based on the allegations.

Advantages and Disadvantages

While this strategy helps make one brand dominant, it makes the other competitors quit, leading to unhealthy competition.

Though, the firms adopting this strategy gain a dominant position, it creates a barrier to the entry of new entrants. The new entrants find it difficult to survive and grow their business. When a firm adopts the predatory pricing trick in the market, it effectively eliminates competition. This is so because, with the pricing strategy, rival companies that cannot bear the loss have to shut down their business to not compete further.

In many countries, setting off predatory pricing is not allowed and is considered illegal. Therefore, it is possible to maintain this pricing strategy only in the short term. The same is not feasible and becomes almost impossible for businesses to continue with it in the long run.

Thus, predatory pricing tactics have both advantages and disadvantages. Let us have a quick look at them:

Limit Pricing vs Predatory Pricing

While predatory pricing involves a huge decrease in the prices of products to pull more and more consumers towards a brand’s products and services, limit pricingLimit PricingLimit Pricing refers to the strategy to restrict the entry of new supplier into the market by reducing the price of the product and increasing the level of output of product and creating such a situation which becomes unprofitable or very illogical for the new supplier to enter into the market and grab the existing market customer base.read more lowers the prices of the products and services to slightly above the average costsAverage CostsAverage cost refers to the per-unit cost of production, calculated by dividing the total production cost by the total number of units produced. In other words, it measures the amount of money that the business has to spend to produce each unit of output.read more.

The former aims to reduce the product prices to a great extent to make other brands in the market invisible to consumers, which drives them off the competition. The latter, on the contrary, is implemented to restrict new entrants into the industry, making survival appear tough to them.